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What’s So Safe About Safe Harbor?

Getting ready to offer a 401(k) retirement plan to your employees? Way to go!

Offering benefits your employees want and need is a foolproof way to attract and maintain incredible talent. Along with an uptick in employee satisfaction, you’ll also gain more tax-deferred savings— it’s a win-win.

Before you go skipping into a field of “I’m-the-best-boss” bliss, keep in mind that offering a 401(k) plan comes with added responsibilities. One of these tasks is making sure your plan is run fairly, and that everyone has the opportunity to fully participate— not just owners and other company bigwigs.

Contributing to a 401(k) comes with significant tax advantages, so the government wants to make sure your plan doesn’t unfairly benefit the company owners and the highest earners. (You may hear these groups referred to as “highly compensated employees” or “HCE”s.) The IRS set up a series of nondiscrimination tests to ensure your plan is fair and encourages participation from all employees.

The IRS Gives Tests?!

There are 3 annual nondiscrimination hoops to jump through.

The Actual Deferral Percentage (ADP) test: This limits the percentage of compensation that HCEs can defer into their 401k based on the average contribution rates of the non-highly paid employees.

The Actual Contribution Percentage (ACP) test: This ensures that the employer matching contributions and any after-tax employee contributions contributed for HCEs are not disproportionately higher as compared to non-highly paid employees.

The Top Heavy Test: This ensures that HCEs cumulatively hold less than 60% of the total plan balance.

In essence, ADP and ACP testing both make sure your plan doesn’t unfairly benefit HCEs, while the Top-Heavy test ensures they aren’t the main people contributors to your plan.

If your plan fails one of these tests, it’s an administrative nightmare filled with costly correctives and piles of paperwork. You may have to return a portion of the contributions made to HCEs or make additional contributions for the lower paid employees. But hurry, if you take too long to make the plan corrections, you’ll owe a 10% penalty. The IRS has Fix-it guides for both ADP/ACP failure and Top Heavy failure but it’s best to prevent the problem before it happens.

Skip the hassle with Safe Harbor

Are you already covered in stress hives at the thought of complicated compliance testing? Trust me, we understand. You’re already running a business and trying to maintain some semblance of a work/life balance— the last thing you need is more administrative headaches. That’s where Safe Harbor 401(k) plans come in

A Safe Harbor plan is specifically structured to automatically pass non-discrimination tests, or avoid them all together. In exchange for getting an automatic pass on the ADP and ACP tests and the extra administrative duties that go with the testing process, business owners must make a minimum contribution to the plan each year—which must be immediately 100% vested.

Are there Safe Harbor deadlines?

Yes! If you are starting a brand new 401k plan and want to have Safe Harbor take effect in the current calendar year, your plan must be fully set up and active by October 1st.

Keep in mind, designing a plan to suit your needs (along with all associated admin tasks) takes time. This means that the very latest you should be finalizing your plan is September 21st.

Is Safe Harbor Right for me?

A Safe Harbor 401(k) can seem like an obvious choice— but it may not be the best option for every plan. Safe Harbor plans are a great fit for small businesses (particularly those with under 25 employees) and businesses that have failed noncompliance testing in the past. But while you save in administrative hassle, you may pay a bit extra in plan costs and required contributions.